Matt Peron: Investing in a Rising Rate Environment

In this episode, Open Windows Host Julie Mochan welcomes guest Matt Peron,  Director of Research at Janus Henderson Investors. Mr. Peron oversees the firm’s sector research teams and analysts, is responsible for the firm’s centralized equity research effort, and heads the firm’s Portfolio Oversight Team.  In this podcast, Matt dives into:

🔸 Inflation
🔸 Deflation
🔸 Recession
🔸 Economic Market Cycles
🔸 Rate Hikes
🔸 The Fed and Volatility
🔸 Sticking to Your Playbook
🔸 Finding Yield in the Bond Market
🔸 Geopolitical Backdrop
🔸 Tactical Investing
🔸 Active vs Passive 
🔸 Sharing Research
🔸 Baseball and Picking Stocks

This interview is filled with great information for anyone in the financial industry.  Enjoy.
At TPFG, our success depends upon your advisory business flourishing 🌳, by doing what is in the best interest of every customer.  Sharing In-Plan advice to those who need it most, no matter your zip code, status, or hairstyle.✨ Since 1984, The Pacific Financial Group, Inc. (TPFG) has built a rich tradition of serving financial advisors and investors with best-in-class investment solutions and unrivalled customer service. The firm was founded on the single premise that everyone, regardless of their account size, should have access to high quality investment opportunities and independent expert advice. Today, we are a dynamic Wealth-Tech firm that blends over three decades of traditional asset management experience with leading-edge financial technology know-how, to provide products and services that empower financial freedom for advisors and their clients.
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Original🎵 by  Ma’aM

More about Janus Henderson , more from Matt Peron and a big "shout out" to Julie Henry for making the JHI interviews possible!

Important Disclosure: This podcast recording has been prepared and made available by The Pacific Financial Group, Inc., also known as TPFG, a Registered Investment Adviser (RIA) offering advisory services. Information in this podcast is to be used for informational purposes only. The information contained herein, including any expressions of opinion has been obtained from, or is based on sources believed to be reliable, but its accuracy or completeness is not guaranteed and is subject to change without notice. The information should not be construed or interpreted as an offer or solicitation to purchase or sell a financial instrument or service. Any expressions or opinions reflect the views of the speakers and are not necessarily those of TPFG or its affiliates. TPFG does not provide tax or legal advice. Investors should consult their financial, tax or legal professionals before investing. Past performance is not a guarantee of future results. All investments contain risks to include the total loss of invested principal. Diversification does not protect against the risk of loss.

Transcript

Open Windows Episode 3: Guest Matt Peron  

[00:00:00] Julie Mochan: Hello podcast listeners, in the land of podcasts. Hello, financial professional, looking for a podcast that can be. Today's your lucky day. This is Open Windows. My name is Julie Mochan, Open Windows is a podcast created especially for financial professionals, looking for opportunity that they may or may not have known existed before. This episode and every episode hereafter will be brought to you by The Pacific Financial Group, Inc.

[00:00:34] Otherwise known as TPFG. The firm that was founded in 1984 on the single premise that everyone, regardless of their account size should have access to the best investment opportunities and the best independent expert advice. 

00:48 Today I have Matt Peron who is the Director of Research at Janus Henderson Investors.

[00:00:53] Matt also heads up the firms Portfolio Oversight Team. If you listened to episode 3, I had another Matt from Janus Henderson Investors and, uh, have come to find through my research that not everyone that works there is named Matt. {music plays The Matt Song-}

[00:01:12] I'll make sure I have the back link to that fabulous song in the transcript. Anyway, Matt is going to talk to us about outlooks that they have at Janus Henderson Investors with him at the helm as Director of Research. And I'm going to ask him some questions, like, like I'm an eighth grader… because I have arrested development.

[00:01:29] That's a joke maybe. Okay. Let's go ahead and talk to Matt and see what we can learn and just FYI have Fidelity coming up in the next month. So, keep in touch, like the podcast, download it, all that good stuff. If you want to hear from us some more and let's talk to Matt now. Matt, Welcome to Open Windows!

[00:01:49] Matt Peron: Thank you, Julie. Thanks for having me.

[00:01:51] Julie Mochan: This will hopefully be just one of many visits because we're in, and I don't like to use this word because it's overused, I think, but unprecedented times or extraordinary times right now. And to have someone with your knowledge of the overall capital markets in a role that kind of makes me nervous to talk to you, but let's think about it this way.

[00:02:13] I am “any age investor”, in the retirement market, somebody that has money in my 401k, and I am seeing what's going on. Of course, everyone sees the news, and I'm getting nervous and I'm not really that confident about how to invest, so I rely on an advisor. I feel like I don't know anything about interest rates, inflation, the market cycles…

[00:02:38] So if we could sort of unwrap all of that and break down your philosophy so that we can understand how you do things at Janus Henderson, that would be super helpful. So, if you want to start with telling us what your inflation outlook is, explain central banks or real interest rates versus nominal. Can you just zero in on that for us right out of the gate?

[00:03:00] Matt Peron: Well, Julie, uh, you're right to focus on that because as investors, whether we talk about it or not, whether it's in the news or not, inflation is the number one, two, and three issue that investors need to always worry about. And that's for any cycle at any time, whether it's unprecedented or not, it's something that we have to focus on.

[00:03:19] And the reason for that is because inflation is typically what ends an economic cycle and hence a market cycle. Meaning that that's when we go into recession and stocks go down quite a bit. And that's because in a typical cycle, inflation heats up as the cycle progresses and then the fed or the central bank has to come in and raise rates.

[00:03:41] And cool the, the economic activity and that causes the recession and then we start again. This time, to use your word unprecedented, I think there is some fairness to that term because we've increased the money supply by 25% and we pumped in a lot of money into the system. And that always generates inflation.

[00:03:58] It’s just the question of how much, and in this case, it has generated significant inflation. So that's why I think you're right to focus on that and why we're focused on that. I'll go into my outlook in a minute, but so far, am I making sense. 

[00:04:10] Julie Mochan: Yes, there are a couple of terms that I just want to clarify.

[00:04:13] So obviously we're talking inflation, but recession is what? Back-to- back quarters of negative… or how many quarters of negative GDP, what is quote unquote recession. And then also, if you could address deflation, because that comes up as well. If the fed starts to tighten and we're not in a growth phase and I don't know what that means either for the market, if you could maybe weave some stuff in like that, that'd be great.

[00:04:40] Matt Peron: Sure. So, coming specifically to your question about in a recession is defined. The standard definition is two quarters of negative growth. However, there was a little bit more nuance to that because the NBER the National Bureau of Economic Research who dates these recessions can actually adjust that and use their judgment.

[00:04:59] Um, frankly you'll know a recession when you see it because you know, everything will be going down. Housing prices, stock prices, et cetera. We've been through that in 2008. We were early in 2020, of course. Uh, so they happen every, you know, five to ten years and the typical cycle is about five or six years. 

[00:05:16] So coming to your question on deflation. So that's ultimately the tight rope that investors have to walk, and that Central Banks are aiming for, which is to balance between deflation and inflation. And as an equity investor, if you're in the stock market, inflation actually is not too bad for you to a point. And the reason why I say that is because earnings from companies are earned in nominal dollars, meaning real dollars, which you get when you pay the cash register, et cetera.,.

[00:05:47] when you pay a bill, the earnings get booked as dollars, and if inflation goes up, and then you get more earnings. So, to a point, inflation is not so bad other than when it gets out of control and then the Fed has to come in, which is the main topic I'm sure we'll talk about in a minute. Deflation is anathema for stocks.

[00:06:04] Deflation is what happens. It happened in the great financial recession of 2008 when prices go down across the board. Those recessionary periods are typically concomitant with deflation, and those are very, very bad for stock markets across the board, whereas inflationary periods are mixed. If you have modest inflation, it's good for stocks. But if you have too much, it's bad for stocks. So hopefully that gives you a lay of the land. 

[00:06:30] Julie Mochan: Yeah. That was great because I think a lot of people, including me, don't understand, I hear the word inflation and you automatically think it's bad, but it's not necessarily bad for growth or balance sheets for companies is maybe what I heard.

[00:06:44] But if it gets out of control, then we get into a place that we're in now and we're going to see the Fed tighten here this year?

[00:06:52] Matt Peron: That's right. And I think you hit the nail on the head. It's good to a point. And we saw that last year, we had quite high inflation last year, but the stock market was fine because earnings were growing really fast

[00:07:02] and the stock market said, “yeah, well, that's terrific for us, and we'll move along with these nominal earnings”, which are inflation adjusted earnings. But now, and this is something we've talked about. So coming to our forecast, last year, we were worried that inflation was running too hot and the Fed was not responding as quickly as they probably should, and that they would have to adjust course.

[00:07:23] And that happened at the end of last year, the end of 2021, when the Fed had to change their posture and say, okay, we really are worried about inflation now and we're going to have to move the timeline up. And we were worried and still are that that would create market volatility, which is what we're seeing now here in early 2022.

[00:07:41] And frankly, when you look at the history of changing from an accommodative Fed, meaning they're pumping money in, to a more restrictive Fed or at least a less accommodative Fed. Those are typically bumpy times the market and they can last four to six months. So, I don't think we're out of the woods, 

[00:07:57] we have more volatility ahead until we really get a beat on how the economy will respond to the tightening Fed, which we expect will start happening probably in March. 

[00:08:07] Julie Mochan: I know I've heard maybe at least two or three hikes, uh, this year. I don't know if that's what you guys are seeing, but that would put rates at what I don't even know if rates are even…

[00:08:20] above ground at all. Where would that put us? At 75 basis points? 

[00:08:25] Matt Peron: So, I think there's the question of what will they do this year, which I think is one question that most people probably think three or four, which we tend to agree with that. Which would put rates around 75 basis points or 100 basis points on the Fed Funds Rate, the policy rate.

[00:08:40] But I think more importantly, we focus on what is the terminal rate. How far are they going to go; and that's what stocks are going to sniff out. And when I said earlier, stocks take about four to six months to get comfortable, that's really what they get comfortable with. They don't really care as much if they are going to do a 25 or 50 (basis points) or three times or four times in a, in a given period, but they're more saying, okay, where does this stop?

[00:09:00] Where does this end? And if it ends at 2%, well, that's a much different story with them than if it ends at 4%. And if the market starts to think that the Fed has to go all the way to 4%, we're going to have some trouble. Equity multiples will compress, and that will be challenging for the market. That's not our base case, but that's certainly the risk case.

[00:09:20] Julie Mochan: Wow. So the market is looking out six, nine months. And are you saying that three to four hikes, up to a hundred basis points maybe are already in the market? Yes.  Okay, gotcha. Well, obviously 4% is not. 

[00:09:34] Matt Peron: That's right. That's not in the market. Exactly. And we think, you know, 2, 2.5% of the terminal rate,

[00:09:40] so where do they stop hiking is probably what the market is thinking. But they thought that was going to be farther out in the future than they did three or four months ago, hence the volatility. So we have six months of volatility, I don’t think the Fed is going to be done…they’re just going to be starting their rate hike cycle at that point.

[00:09:57] But typically, if you look at historical cycles and we've done this going back 50, 60 years; Four to six months before the first rate hike, you start to see volatility in the market. At the first rate hike typically is when the market calms down because, now we know what the pace and the terminal rate is going to look like.

[00:10:14] That's typically what happens, and then the market can resume its growth alongside earnings. So, we're much more constructive on the back half of 2020 than we are on the, for the front end. 

[00:10:24] Julie Mochan: That totally makes sense. I mean, I think that's just life in general. If you're expecting something to happen, and it hasn't happened once it starts to happen,

[00:10:31] whether you're building a house, or I don't know, shoveling your driveway, you feel a lot better after it has started. So, you're thinking that volatility might calm down a little bit after the first hike takes place is I think what I heard.  I have a question about when you are talking about historically what the Fed has done.

[00:10:52] Do they traditionally always screw up? {laugh] I guess I shouldn't say it that way, but it just seems like they're always kind of reacting. 

[00:11:04] Matt Peron: Yeah. I think that they certainly get that criticism a lot. They always have critics, right? And they've always had people look back and say, “you could have done this better,

[00:11:11] you could have done that better”. So, they have a tough job. But this time people have fair scope to criticize and say, hey, you should have seen that inflation was going to be stickier than it probably was, it was obvious to most people. And so I think there's some fair criticism this time, um, that they have potentially earned, but…

00:11:30] Julie Mochan: That transitory word that we kept hearing.

[00:11:34] Matt Peron: That's right. That's right. 

[00:11:36] Julie Mochan: All right. Let's talk about your specialty. How do you allocate for growth or just for like staying the course in an environment like this, where the uncertainty is so high, and the volatility is sort of currently off the charts. How do you do that? 

[00:11:53] Matt Peron: So, I think first is we have a playbook, right? And we have a whole cycle playbook that's tried and true and you want to stay somewhat faithful to the playbook because most economic cycles and market cycles typically play out with a certain similarity. They're a little different depending on the backdrop, and so we adjust that. So, the playbook is generally early-cycle, or you're pretty aggressive in your investments, mid-cycle, you tamp it down a little bit and then late-cycle, you take risk down even more and then try and look for signals that the economy is actually moving into recession and then you'll go underweight risk. So, with sort of the contours of that playbook is…. we're following that, which is to say we had earlier on in the cycle, say, summer of 2020, we really started putting pedal to metal,

[00:12:42] and now we're transitioning to this mid-cycle. So, we’re still pro risk, we still want to stay overweight risk. We think that equities will grow with earnings, which is different than early cycle when they grow with earnings, as well as multiple expansion (so, you get a double-whammy). Equities, typically mid- to late-cycle are much more muted in their returns, but they're positive returns,

[00:13:04] and more importantly, they're better typically than bonds. And I think in this cycle, there'll be particularly better than bonds. So, we're constructive still on equities, although we're not expecting a lot, but we're very cautious on bonds. So, we're staying overweight, equities, short duration (in bond terms), and overweight credit.

[00:13:23] Julie Mochan: Can you explain to people, if rates have been this low for so long and they start to tick up, what happens to the price of treasuries versus corporates? Um, just for someone who doesn't know anything about the fixed income market. 

[00:13:38] Matt Peron: Yeah, sure, it's an important point because people think, well, Treasuries, “I’m safe”, and investment grade bonds, “I'm very safe, these are high quality, high rated bonds.” And that is true from a credit perspective. They're not going to default on the bonds, but the bond prices will go down because they're inversely correlated to rates. That's just math. And so if rates go up, bond prices will go down.

[00:14:01] So we're mindful of the fact that we think rates will continue to grind higher throughout the rest of this cycle. And that means bond prices will be under pressure. So, bonds to hold will go down. So that's the key reason why we think that equities will be better performers than bonds, even though they'll probably only be 7% per year, not the 15-20% that we've been used to, but there'll be better than bonds, which might actually have negative returns or close to zero.

[00:14:26] Julie Mochan: Thank you. I have something to add to that, cause I don't want to quite leave the Asset Allocation piece that we want to talk about yet. So, there's two things I'm going to throw out at you right now. One is, typically people move to treasuries as a place that they feel as “safe”. But if you can't get any return or yield there, um, where do you go?

[00:14:49] Right? So that's one piece of the question for you. The other piece is, if I'm an advisor talking to someone who's getting ready to retire (I'm talking like the next two years) right. How do you... how could you possibly allocate, uh, do you use tactical? Like, what do you do there? 

[00:15:06] Matt Peron: So, yeah. Great question.

[00:15:07] So there is a middle ground, right? You do want to be mindful of the interest rate phenomenon. We spoke about interest rates going up, bonds will go down. But, you know, full on equity risk, you might be too nervous about. And I understand that, we understand that. So, uh, coming here to the first part of your question, typically the middle ground that we like, is to play some of the credit sensitive parts of the bond market. So not all bonds are interest rate sensitive. Some bonds are much more credit sensitive than interest rate sensitive, and what that means is they're actually “riskier bonds”, so to speak, from a credit perspective. They are businesses that you're taking some risk to lend to them, 

[00:15:48] but not too much risk. They're not typically going to default…

[00:15:52] Julie Mochan: They're not junk. 

[00:15:54] Matt Peron: They're not totally junk, they're in that middle, in this sort of a hybrid in a sweet spot. BBB to use the exact terms. So, um, that type of area. So, we'll allocate there, we get a nice coupon, and you get good risk adjusted returns.

[00:16:07] You get nice income, you get some risk, but not equity risk. And you're safer if rates do go up, they tend to hold their ground much better than a government bond would. 

[00:16:17] Julie Mochan: That's good to know. Let's look at the geopolitical risk because I literally, just yesterday or today, I watch the news every day, right?

[00:16:26] Like everyone does, but I try to turn it off (just to center myself) because it's really, there is a lot going on. Obviously, you know this with your position. I hear about Ukraine. I hear about China. I hear about a lot of other countries with their problems, with yield or even energy prices and oil, and what's going on there and us going ESG, there's so much swirling around.

[00:16:56] How do you take that variable? Because it's, there's no way you can't really predict it. I guess you I'm sure you have models that can. What do you do there? It's really tough to keep a customer or a client in a position where they're not really nervous when they're listening to the news, right? 

[00:17:18] Julie Mochan: So taking geopolitical risk into account, how do you even talk about it to moving forward with everything else?

[00:17:29] Matt Peron: Yeah. So, that’s a key point, and I think there's just two ways to approach that. One is why we advocate for being tactical in your asset allocation, because you will get opportunities or you will get these unexpected draw downs in the market, and you want to use those as opportunities to allocate.

[00:17:47] So for example, at the moment, we know that there's going to be volatility, we have some dry powder in our asset allocation to tactically take advantage of it. So, you can't forecast these things, as you say. And we've looked at all of the geopolitical events over the past 50 years and how long they last and the average, and all that.

[00:18:06] And typically they are short-lived. They're episodic events and they typically recover quite quickly - like when we invaded Iraq, or even the pandemic, the markets recovered quite quickly. So, they're very, very hard to forecast and all you can do is be tactical and take advantage of it and use it to your advantage from a market standpoint.

[00:18:32] So, I know it sounds flip to say this Julie, but when it comes to investing, tune that stuff out. You know, it's just not something you can really plan for, other than to be ready for it when it happens. 

[00:18:45] Julie Mochan: That's great advice. I was just looking at a chart the other day, where March, was it March of 2020?  You know, where the market went down so far, came back so quickly that it's not even, you know, you can hardly call it a blip when you're looking at the chart.

[00:18:58] I mean, everybody that was in the midst of it, didn't feel like that, but that's great advice. All right. So tactical is huge in this type of environment, it sounds like. Can you explain a little bit about ETFs versus open-end funds and utilizing allocations there and how you feel about active versus passive investing going forward?

[00:19:20] Because passive investing got really very popular for a while because of fees (I think because of fees) but if you could give us your stance on active versus passive. 

[00:19:31] Matt Peron: Yeah. So, we in general favor active investing, we think over a full cycle, especially when rates are rising, active investing typically gives you the full tool set that you need to deal with that. When rates are going down, and they're grinding down, and when markets are not volatile, et cetera, then there's a place for passive, no question.

[00:19:53] But as we get into inflation scares, geopolitical scares, you have Fed regime change, et cetera. We favor active because we want that tool in our arsenal. So we favor that at the asset allocation level, we favor that in our underlying funds be they mutual funds or ETFs, and it just gives us more levers and more tools in our toolkit to react to these things to take what are hiccups or speed bumps, or even worse episodes in the market and use those to our advantage.

[00:20:24] We have a very large research team. We're constantly putting out research, uh, internally. And we also will share much of that with our clients. Our tagline to our firm is knowledge shared. So, we'll put out quite a bit of blogs, research, white papers, outlook papers. We do podcasts too numerous to name. So as a 400 plus billion-dollar asset manager covering every asset class, you can assure that we have thought about most of the things that are on investors.

[00:20:53] Julie Mochan: That's fabulous. And I know that already because I use some of your research. Hey, before I let you go, tell us something about yourself, Matt, something kind of fun or cool.

[00:21:06] Matt Peron: I don't have anything fun or cool because I'm a total nerd. Um, but as a nerd I can tell you that I'm a big baseball fan and love the sort of strategy that goes into baseball, and bring that a lot to how I think about investments.

[00:21:19] So, you know, it's a nerd sport, but actually the strategy has some interesting implications as to the analytics that they bring to bear. So that's maybe a tidbit. 

[00:21:29] Julie Mochan: That's amazing. I'm one of those people that I I'm like, all right. I had a hot dog. I had a beer. Uh, this is getting boring. You know that by the time the seventh inning stretch comes around, I'm like, all right, how do these people sit here and watch this game?

[00:21:46] That's an incredible thing that you just said. I've never heard that except for what was the movie? Um, Moneyball? Yeah. 

[00:21:54] Matt Peron: So Moneyball is very much like investing it's how do you hit singles and doubles and how do you maximize your chances of winning? And that really is I, I give it to a lot of our associates that book, because it, the analytical approach to baseball can also be applied to the stock market and to picking stocks.

[00:22:11] Yeah. So, if you're really thoughtful, Looking at a company from all angles and you maximize your chances of winning by really approaching a company from, an analytical perspective, a very rigorous, uh, perspective. So there's some overlap there and it's a fun way to, to sort of, you know, hopefully make it more interesting for people.

[00:22:33] Julie Mochan: I will not look at baseball the way I have looked at it for the past. I won't say how many years I'm going to watch a baseball game now.

[00:22:41] Matt Peron: Even though it looks boring, there's a lot of strategy and a lot of thinking about. And there's all kinds of considerations. You need to take advantage of that, that you may not be aware of.

[00:22:50] So hopefully we'll make it a richer experience for you next time we a 

[00:22:53] Julie Mochan: Even a like the Pirates? [laugh]

[00:22:59] Yeah, no comment. Right. All right. Cool. Hey, thank you so much for spending time with us today and looking forward to having you back. We really appreciate it Matt!

[00:23:08] Matt Peron: look forward to doing thank you so much. 

[00:23:11] Julie Mochan: There you have it, until the next episode. Remember, you don't need to work harder, just work smarter by Opening a Window.

[00:23:19] This is Julie Mochan with the TPFG Open Windows Investing podcast signing off.

[00:23:31] This podcast recording has been prepared and made available by the Pacific financial group incorporated. Also known as TPFG a registered investment advisor. Offering advisory services information in this podcast is to be used for informational purposes. Only the information contained herein. Any expressions of opinion have been obtained from, or is based on sources believed to be reliable, but its accuracy or completeness is not guaranteed and is subject to change without notice this information should not be construed or interpreted as an offer or solicitation to purchase or sell a financial.

[00:24:06] Or service any expressions or opinions reflect the views of the speakers and are not necessarily those of TPFG or its affiliates TPFG does not provide tax or legal advice. Investors should consult their financial tax or legal professionals before investing past performance is not a guarantee of future results and all investments contain risk to include the total loss of invested principal. Diversification does not protect against the risk of loss.

[00:24:33] Have a nice day.